Startups

5 Signs Your Startup Hit a Plateau

The startup graveyard is full of companies that enjoyed initial success — call it beginner's luck. But often, good news can become the worst enemy of a growing company. We call this paradox "the plateau effect.“

Everything we do in life follows this familiar pattern — love, playing music, learning how to swim. We succeed, then we get stuck. It's obvious to anyone who's sat through an economics class and studied the law of diminishing returns, or what we call saturation. When everyone in the world drinks Coca-Cola, how do you find new customers?

But startups hit plateaus long before they run out of customers. Here are five ways early success can lead to ultimate demise.

Pretotyping vs. Perfectionism

Electric car startup Coda is the last victim of the overly optimistic green startup movement. It filed for bankruptcy March 1 after raising $300 million from heavy hitters like Aeris Capital and burning through much of it. It seems customers didn't care for the plain-Jane $37,000 cars. That's an expensive misstep, and negative feedback that should have been caught in the prototype stage or sooner.

Pretotypes are incredibly low-budget product versions designed to reach customers' hands well before any large investments. The classic example is the original Palm Pilot: Users carried around the pretotype, which was actually formed from a block of wood. Sure, that's a clunky solution — we don't expect anyone to drive a wooden car around his or her neighborhood. But there are hundreds of ways to get cheap mockups into users' hands before creating a full-fledged product. Doing so radically speeds up the evolutionary process and saves a lot of money.

Startups are typically led by technical people, not business people. Technical people will make the most complicated but technically impressive product possible. They sometimes insist on shooting for a perfect product before even trying it with customers. Often, the product bombs and the company either needs to pull a "tech pivot" or go out of business.

The “pretotype” fast-fill model and the agile software development model show it’s more important to get less-than-perfect products into customers’ hands at every step along the way. That way, iterations can cycle in weeks instead of months or even years.

Failing Slowly

The slow fail is a related concept. Startups should prefer a quick implosion over an okay reception, followed by milquetoast sales. Better to go down in flames with new ideas than to expire slowly like a frog in a boiling pot.

Craigslist is the classic example of failing slowly. It had a first-mover advantage that rivaled Amazon and eBay. Yet the site feels and works much the way it did in 1999, and while it is still popular, smaller firms are managing to steal customers and, thus, pose a threat. At the moment, Craigslist is reduced to suing these competitors for copyright infringement, and beating back accusations that it is stymying competition.

Formspring, the Q&A service that enjoyed one of the most meteoric rises in Internet history, also exemplifies a slow fail. Within a year, the service had millions of users who had asked billions of questions, but the fundamental anonymity of the service was its rotting core. The site attracted abusive behavior and a bad reputation, and it spent nearly all its energy trying to retrofit standards on its users.

Cap Watkins, a former lead designer for Formspring, said this was the biggest strategy failure. “When you find yourself constantly giving a feature CPR, you should stop and consider whether or not it’s worth saving (or even possible to save),” he wrote in a blog post. They are now in the deadpool.

The Greedy Algorithm

Corporate America's latest management trend — taking public companies private — is a precise reflection of the problem of the greedy algorithm, a principal familiar to those who work in higher mathematics. Unguided by external wisdom, computers and people will both opt for the most immediate positive outcome possible.

As a public company, managers believe they are required by law to work in 90-day sprints that maximize quarterly results to please shareholders. To be free of this insanity, and of the greedy algorithm, companies like Dell are seeking to de-list from the stock market so they can reorganize with longer-term goals, away from the greedy eyes of shareholders.

Why does this matter to startups? Many fall into the trap of grooming themselves for an exit too early. The problem is that many smaller firms follow the greedy algorithm — settling for short-term gains at the risk of long-term goals. They prize smaller sales this year over potentially bigger deals next year; they inflate their short-term revenue numbers expressly to inflate their revenue-based acquisition price.

Firms also do misguided things to show a monster quarter when, in fact, steady quarter-over-quarter growth tells a better story, as valuation is often based on "the art of the possible.”

Meanwhile, many firms achieve acquisition only as a precursor to destruction. The highly-publicized Twitter acquisition of Posterous is a good example. The quick-blogging service was a cult favorite before it sold to Twitter, which summarily shut it down. What was Posterous' true potential? We’ll never know.

Step Functions and Other Flow Issues

Growth is never a linear process. Most moments require fresh, heavy investment.

For example, a thriving restaurant with 30 tables hits capacity. It can’t add a 31st table, so it must lease the space next door and suddenly double rental space costs. This is called a step function, and firms often fail by executing these steps poorly. Smoothing out steps is critical, as is planning for them.

Webvan is the classic expand-into-failure story. After San Franciscans told the firm they loved getting groceries delivered with 30 minutes, Webvan decided to spend $1 billion constructing distribution centers all around the country. By the time the rest of the country was ready for at-home onion and banana delivery, Webvan had spent itself to oblivion.

The cloud has begun to address some of these step function issues — don’t buy a server farm, just rent one. An emerging “subscription economy” is creating even more granular tools for smoothing out step functions, such as the startup Zuora, which aims to let other startups rent nearly anything they need.

Listening, or Not

No consumer ever got a chance to listen to Beyond Oblivion, a heavily funded music subscription service backed by Ruport Murdoch. It burned through millions making specialized hardware and paying up-front for licensing agreements that it ultimately never needed. Beyond Oblivion spent around $100,000 on prototypes to make sure its service worked on various devices, according to Evolver. Just before New Year’s Day 2012, it shut down before it ever collected money from a customer.

The bold thinking and risk-taking that are the hallmarks of every successful entrepreneur often become a company’s undoing once it matures. Starting a company often involves ignoring doubters and pigheadedly taking a leap of faith. But later, that kind of pigheadedness leads executives to ignore critical warnings signs, like unhappy customers or negative research.

Related, many executives and companies succeed because of accidental reinforcement. Maybe your firm took off, but it wasn’t because your product was a hit, but rather because an unknown parallel product dragged you along for the ride – temporarily.

It’s very hard to unlearn what you think you know, to stop repeating, “But this worked before.” The minute someone in the room says that, you’ve hit a plateau.

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